Peak Debt

Is there a limit to how much Americans can spend? Clearly there is: All they earn, minus savings and service on their existing debt, plus new borrowing. Since the Bureau of Economic Analysis puts numbers on those very items, it's possible to see just how close we are to the edge. In a fascinating paper, Ron Laszewski does exactly that. The results are rather depressing.

Laszewski has kindly let me post his peak debt paper itself on my personal website, so you can read it yourself. What follows here is a quick look at his conclusions (with just a glimpse of the math that's in the paper).

Quick overview of the analysis

Basically, what Laszewski does is turn that simple statement of the limit to spending--all you earn, minus saving and debt service, plus new debt--into an equation. Then, he fits that equation to the historical data from the Bureau of Economic Analysis.

Since income has been flat since the 1970s, increases in spending since then have had to come from somewhere else. They came first from a decline in saving, and then from an increase in borrowing. (Not surprisingly, these changes went hand-in-hand with a decline in interest rates. If there's scarcely any return to savings, why save? If there's scarcely any cost to borrowing, why not borrow?)

In about 2005, though, the "new borrowing" term hit its maximum. According to the data, Americans as a group had, by then, reached the peak in the rate at which they could take on new debt. Unable to take on new debt at an increasing rate, growth in spending would have to shrink--and that is exactly what the data show.

What does it mean?

The depressing results that I mentioned at the beginning go beyond just a decline in the growth of consumer spending. Under any plausible scenario, consumer spending actually drops--and, in fact, drops by quite a bit.

Since consumer spending is a large fraction of the economy, a drop in consumer spending inevitably means a recession. The analysis in this paper suggests a rather severe one.

Alternatives

When I read an early draft of the paper, I suggested that things wouldn't really go along this path--people wouldn't just let the enormous debt load grind them down. Instead, we'd see a mixture of ways to eradicate the debt without paying it off (some combination of inflation and defaults of various kinds--restructurings, bankruptcies, debt holidays, etc.).

Assuming that this little model reflects reality, it turns out that none of these things really make much difference. Under every scenario that we've been able to think of, consumer spending declines sharply--and remains depressed for decades.

A model

It's important to note that what Laszewski has created is a model. It's a little toy version of the economy that you can make changes to and set to run and see what the economy might look like. The actual economy is a real thing. Whether the model reflects reality remains to be seen.

However, after doing his initial analysis, Laszewski found some data on residential mortgage debt between 1913 and 1940, which let him do a similar analysis for that period. Fitting the curves to that data shows that America hit peak debt in 1925, with the great depression setting in about 5 years later. The equations fit the data very nicely--one piece of evidence that the model may well reflect reality. (Laszewski's analysis is in Appendix A in the paper.)

People who are familiar with the model of "peak oil" will see certain parallels here--because the data turns out to fit a logistic curve (as does growth oil production)--a fact that Laszewski notes in the text:

The shape of the rise in total debt shown is also very well fit by the logistic growth equation. The rate-of-change in the logistic growth curve implies that new borrowing probably reached its peak in 2005 and is now in decline. We will refer to the peak in the rate of accumulation of new debt as Peak Debt, in conformity with the popular use of the designation “Peak Oil” to refer to the maximum in the rate of petroleum production.

What to do?

As far as what to do in managing your affairs, I'm afraid I don't have much in the way of new suggestions. Certainly, avoid running up new debt of your own. Be concerned that many other people's debt is not all going to be paid back, and let that fact guide your decisions about where to invest.

Arranging your life so that a sharp and long-lasting decline in consumer spending won't destroy both your job and your investments at the same time is a most excellent idea--I wish I were in a position to give you some more specific suggestions about just how to do that.

If you're at all interested in the math, I strongly suggest that you read the peak debt paper, rather than relying on my analysis.

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Anna_esq #1

Depressing, but not surprising. Government is banking on consumers to pay off financial services bailouts, but John Q. Publick (JQP) is tapped out. He's been forced to compete with people earning $.50/hour in other countries, illegal immigrants here, pays taxes to maintain our infrastructure while the wealthiest 1% pay almost nothing, pay inflated mortgage prices on a home he overpaid for because the bank and appraiser he relied on to be a reality check told him it was a good investment, and he's drowning in debt. Yeah ... JQP was nieve for digging himself into debt but, after all, isn't this the lifestyle he's had pounded into his head by the government and media since kindergarten? Even now, the government is telling consumers they can "save" the economy by spending money...

I find it interesting that gold jumped almost $80/oz in the last few days. The wealthy are converting their wealth into inflation-resistant gold, while the rest of us are put on the hook by our so-called elected officials to bail their mess out. Stagflation is coming!!! Although it's about peak oil, not wall street collapse, the book "The Coming Economic Collapse" has some sound advice about how to deal with stagflation. Of course, with gold $80 more expensive, not sure that won't become the "new bubble."

I just hope people are smart enough to stop their stupid "lipstick on a pig" versus "rock star" media focus and start demanding REAL answers from their elected officials. We need viable third-parties in this country to hold the major parties feet to the fire or we're in for a long miserable ride to the bottom.

I agree with guest. Quit blaming your problems on other people - immigrants, the media, the government, etc. and focus on what you can do yourself and what you can control. It's the only way to live a fulfilling life.

You know, I come to Wise Bread looking for moral support to encourage my frugal lifestyle. It's tough pinching pennies and reminding yourself to be frugal once you "make it" in your career. Yes, life has been good to me. However, life isn't so good for a lot of other people. In fact, as our family has gotten richer, the families my kids play with, our neighbors, my clients, and the families of the people we employ have gotten a lot tougher. A few of them were spendthrifts who "blame everyone for their problems," but most of them are harder working and more frugal than anyone here on this web site (including myself). I've decided to "come out of the closet" with my frugal lifestyle in the hopes less affluent people see it's OK to choose not to consume.

However, the number of readers spouting the old tired "all you stupid people with gas guzzling SUV's" party line is offensive. Hello, anybody? What planet do you live on? Planet Citibank/Big Bank Lobbyst? Why ANYONE would choose to make themselves feel good by telling others their hardships or the current economic imbalance is "all their fault" is beyond me. Especially since many readers, I imagine, may be visiting this website for the first time to learn about getting their consumption under control. Gee, that's smart, lets tell the newbies they're all stupid so they leave and never come back.

I can't imagine why ANYBODY looking for frugal moral support would visit this website, no matter how good the writers are, because the unpoliced forums are, quite frankly, offensive. I can laugh at caustic people with low self-esteems from behind the fortress of my considerable salary and wealth. However, other Wise Bread readers are hurting right now and don't need to get beaten up on by other readers. Wise Bread has the nastiest, most sarcastic reader posts I've ever seen on any website and I, for one, am giving up on surfing here. Go ahead and quip your "all your fault gas guzzling SUV" comments ... I'm not coming back ... and I'm de-listing Wise Bread as a resource for the "do it yourself" legal clinics I teach. Get a life, nasty people, or go visit "Ann Coulter Online" if you feel the need to continuously spout hatred of your fellow American.

The current problems--both the problems that we all face as individuals, and the greater problems that we face as a society--have their roots in many sources.

It's sometimes hard to find the right balance between supporting the people who are hurting (which is important to do--and something that I think we do well here on Wise Bread) and talking about what brought us to this unhappy pass (which is also important to do--to understand the nature of the problem and to inform us in our search for a way out).

I sometimes cringe at the "fugaler than thou" attitude a few of our readers show in their comments--but I rather suspect that most of their ire is really aimed at themselves: They're saying what they wish someone had said to them, back before they made some poor choices that have made their path harder than it needed to be. If their comments seem mean, understand that they're trying to find words that might have gotten through to their younger selves.

I urge everyone to keep the dialog here on Wise Bread a positive one, that focuses on finding solutions. And that when we do talk about the causes of the problems that we face, we do so with the goal of understanding them, not of assigning blame. (And I say that with a pretty positive attitude myself, because I think we do a pretty good job of that.)

I certainly understand how difficult it can be to listen to comments that seem set on finger-pointing rather than support. One of the reasons that I enjoy writing for Wise Bread is that I truly have found a group of readers and writers who can share ideas that have positively affected my families frugal living lifestyle.

That being said, as part of a blog with an appreciation for free speech and sharing, we do get a wide variety of commenters, who may or may not have the eloquence to speak their differing opinion with tact or compassion. As writers, we often get our share of nasty comments or short-sighted remarks, and try to deal with them appropriately.

Anna, I can't speak for everyone here at Wise Bread, but as much as we desire to have a diverse audience, we would never want it to be at the expense of those who have supported us so graciously over the years with thier positive feedback and comments. I encourage you to use the "Report this Page" button at the bottom of any post you feel is inappropriate, and the Moderators will look into it ASAP. We have often allowed some "venting" to occur as a way for readers to give voice to the frustration that they are experiencing in their lives. We would not, however, wish for this to trump the feelings and considerations of those who come to Wise Bread for a supportive environment.

Please feel free to email us directly with your questions or concerns. Our readers mean more to use than anything, and we hope to resolve any issues you or others may have in both the comments and forums.

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Short on extra minutes, but wanted to chime in. Readers are an important part of our site here, and we want everyone to feel they have a voice. That being said, there are comments from time to time that people find a bit snippy (to say the least).

As writers, what Linsey said is true. We also get our fair share of snipe and sarcasm which can be hurtful and a bit hard to take at the end of a long day when we just wish our efforts to log in and take the extra time to respond to questions was appreciated (which by most readers it is)instead of having to respond while exhausted to what we feel is a hurtful or ill thought out comment.

That being said, I've lived with full blown censorship before and while I totally respect the ways and cultures of those countries where it takes place, it's not my cup of tea. I guess what I'm saying is, it's a balance to allow everyone their opportunity to chime in without fear of censorship, and keeping things where we all want them to be . . . civil and conversational.

When the topic involves money, something people are emotional about during even the best of times, things can get volatile. That's where we rely on people to refer to the terms Linsey mentioned above, and also to do their part to address the issues as they see them and be open to commentary that may (and frequently does) have a different view point.

We don't expect everyone to agree all the time, and we understand that many of these issues and strategies are ones we try to figure out as best we can as we plug along through life.

While I understand that you (Anna-esq) may be sick of the "all you stupid people with gas guzzling SUV's" line, you have to understand that no one said that in the comments. The guest and Matt merely mentioned to you that it's not illegal immigrants fault either. I only saw finger pointing from you. Although I am not trying to be confrontational, you have to understand that this site does draw all different types. When you make blanket statements, some people might call you on that. I love a good debate, and if you can point out to me where "illegal immigrants" are the source of our country's problems I will plan a well-thought out response. I don't think that threatening to de-list Wisebread on your blogroll really sums up your side of the story.

Great post on consumer debt as an economic driver. In the past, I have typically adopted the thought process that spending (and taking on more and more debt) in a macro kind of way can be good for the economy though in the micro view (that is for me and my family) spending should be controlled. All those micro-events (families being in debt, in general; and taking on un-pay-back-able mortgages specifically) though are now at the center of problems not only of the US economy but world economy. You are making me want to dust off my Macroeconomics and Microeconomics textbooks.